The airline industry has not always had the best reputation from a stock investment perspective. Investors have begun to change that perception, but some doubts linger. We just can’t seem to trust them to not squander away profitable operations. And recently, terrible viral videos of poor customer service have made their way to the forefront and the stocks suffered through weeks of turbulence as a result.
Southwest Airlines Co (NYSE:LUV) is one airline that has a better reputation for its business acumen than most others. So it carries an earned premium for that. LUV stock is up 16% in the past 12 months, even after its correction that started in July.
Compare this to United Continental Holdings Inc (NYSE:UAL), which is down 17% in a year, JetBlue Airways Corporation (NASDAQ:JBLU) is down 11% and Delta Air Lines, Inc. (NYSE:DAL) is flat. So those who paid the premium for LUV stock got what they paid for.
Fundamentally, LUV is not cheap relative to its competitors, but that has always been the case. Even so, its price-to-earnings ratio is only 15, so it’s not bloated either. Wall Street analysts have a buy rating on it and they see upside potential from here. Yet it still trades 10% below the lowest of their targets.
A Bullish Trade in LUV Stock
Today, I am sharing a bullish trade in Southwest stock that would benefit from the expert opinions, but won’t depend on it. I am betting that the neckline support will hold through year-end , but if I am wrong, I am willing to own the shares.
Click to EnlargeTechnically, Southwest stock is trading just above a very important zone. The area around $51.50-per-share has been pivotal for over a year. It had served as resistance, but in January 2017, the bulls prevailed and the stock rallied 25%. It has since given back most of it, but the breakout line remains intact. It has already served as support twice.
And therein lies my opportunity. Today, I want to sell downside risk below but leave enough room for error.
Although I am betting against it, I do have to recognize that there is a chance of a technical breakdown. So far, the pivotal support has held, but if it breaks then LUV stock will have to contend with a bearish pattern that could target $44-per-share. This is best evident on the weekly chart. So, I consider this a speculative trade in a conservative portfolio.
The Bet: Sell the LUV Dec 29 $52.5 put for 60 cents per contract. Here, I have a 85% theoretical chance of success. Otherwise and if the price falls below it, then I would suffer losses below $51.90.
Selling naked puts comes with big risk, especially for an airline stock. For those who want to mitigate it, they can sell a spread instead.
The Alternate Bet: Sell the LUV Dec 29 $52.50/$51.50 credit put spread. The spread has the same odds of winning, but it would deliver 25% yield on risk. Neither trade requires a rally to profit. In fact, the stock can fall an additional 5% and I could still retain my max gains.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.